OPEC has its reasons for wanting to keep a lid on crude prices

Crude oil prices dropped to its lowest Dec.2 for the first time since August to $39.94 a barrel (AP Photo/Eric Gay)

Crude oil prices dropped to its lowest Dec.2 for the first time since August to $39.94 a barrel (AP Photo/Eric Gay)

Photo: Matt Slocum

Photo: Matt Slocum

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Crude oil prices dropped to its lowest Dec.2 for the first time since August to $39.94 a barrel (AP Photo/Eric Gay)

Crude oil prices dropped to its lowest Dec.2 for the first time since August to $39.94 a barrel (AP Photo/Eric Gay)

Photo: Matt Slocum

OPEC has its reasons for wanting to keep a lid on crude prices

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The military has an axiom that no plan survives first contact with the enemy. That’s because the best military officers know the enemy is constantly learning and adapting.

Executives should know that every business plan must be flexible to respond to competitors. But last year U.S. oil company leaders were caught flat-footed when their biggest competitor, the Organization of the Petroleum Exporting Countries, didn’t prop up prices. It looks like Americans may be making the same mistake again.

Oil prices have risen in recent weeks as new data shows North American production slowing down in late 2015. Some analysts believe that once the current glut is gone, prices will march upward to where shale drilling makes sense again. This prediction, though, relies on OPEC maintaining production and prices at current levels.

That’s a dreadful mistake because the most powerful OPEC countries will likely keep prices from returning to last year’s levels, about $90 a barrel for the international benchmark Brent crude. Many in OPEC will be happy to keep prices where they are now, around $55 a barrel, because it stokes demand and keeps competition out of the market.

Many analysts disagree, arguing that OPEC governments rely on national oil companies as cash cows. When the price of oil goes down, the governments can’t pay for the programs that pacify their citizens and risk revolt. Ergo, OPEC governments need prices above $90 a barrel for Brent crude to pay for generous social programs.

If Saudi Arabia, the de facto leader of OPEC, is feeling any pain, however, oil minister Ali al-Naimi wasn’t blinking at a conference on April 7 in Riyadh.

“The challenge is to restore the supply-demand balance and reach price stability,” he said, according to Bloomberg News. Despite a glut of crude, Saudi output has risen to 10 million barrels a day, and Naimi said that will not change. Russia is pumping oil at record levels, and in 2015 the U.S. will produce the most crude since 1972.

OPEC is not cutting because $90 oil is expensive for people in developing countries where most of the growth in oil demand is expected. Wealthy Europeans and North Americans are using less and less oil every year, largely because of climate change concerns.

Last year China became the world’s largest energy consumer, largest purchaser of automobiles, largest petroleum importer and largest carbon dioxide emitter. China remains a key source of oil consumption growth, with a projected annual average increase of 300,000 barrels a day in both 2015 and 2016, according to the U.S. Energy Information Administration. But that’s down from 400,000 barrels a day in 2014.

Customers of the future

OPEC’s future customers live primarily in developing East Asian nations, according to Jim Krane, an expert on OPEC at Rice University’s Baker Institute,

“To the extent low oil prices can boost demand in Asia and help the economy in China, that is part of their thinking,” Krane said. And leaders in OPEC, like Saudi Arabia and Kuwait, are looking to make sure demand in Asia will last for generations.

Developing countries, by definition, are making strategic decisions about how to grow, Krane explained. If oil is expensive, planners will make low-energy choices, such as designing compact cities that rely on public transportation and fuel-efficient vehicles. But if oil is expected to remain cheap, planners may design more sprawling cities that rely on energy-intensive vehicles.

“The choices you make now will affect demand for decades, or centuries, even,” Krane said. “If you’re OPEC, you’d like to see countries developing more energy-intense city design.”

Substitute technologies

High oil prices are also what led to so much competition in the energy market, ranging from hydraulically fractured shale wells in Texas, to deep-water operations off Africa to a massive lithium battery factory in Nevada.

“The substitute technologies come online when the price for oil is high,” Krane told me. “Cars all of the sudden get smaller, you get these weird new technologies that get more oil out of the ground. Drillers go offshore, and refiners try to get oil out of coal or natural gas.”

But what about those government budgets?

“Naimi has said that the Saudis are happy to go into deficit spending, and even into debt, to finance their government budgets for the next few years,” Krane said. “The last oil bust lasted two decades, and all of the Gulf monarchies survived intact, so these guys know how to survive a bust.”

Low prices are tougher for less wealthy OPEC countries, such as Iran, Iraq and Venezuela, but none of those countries has the power to raise prices alone. Ironically, if unrest does break out and endanger production from these countries, prices will spike and give them the cash injection they need.

Cutting fat

Michelle Michot Foss, who heads the Bureau of Economic Geology’s Center for Energy Economics at the University of Texas, said that during a recent meeting, OPEC ministers spoke frankly about needing to cut fat from their budgets and to diversify their economies.

“They see erosion of demand in response to price, and that’s something they think they can do something about,” Foss told me. “If you take that fiscal contribution to the state out of the picture, they are cheap and they have lots and lots of volume.”

Planning accordingly

In its short-term outlook, the Energy Information Agency forecasts that Brent crude will average $59 a barrel in 2015 and $75 a barrel in 2016, with Texas crude trading about $6 cheaper. But that assumes no increase in production from OPEC. If sanctions on Iran are lifted and the country adds 700,000 barrels a day to the market, the agency says to subtract $15 from the 2016 forecast.

The American oil industry needs to take OPEC’s desire to encourage greater oil use while maintaining market share very seriously. And that means planning for $60 Brent in 2016 and possibly for years to come.